Assumptions Made in CVP Analysis Number of output units only revenue driver and only cost driver Total costs can be separated into the primary categories of variable costs and fixed costs Total revenues and total costs are linear within the relevant range (and time period) Unit selling price, unit variable costs, and fixed costs known and constant Single product or constant sales mix Time value of money effects ignored 4.

Manufacturing costs Non-manufacturing costs If the firm sells 5,000 units per period, what price should be charged to earn $35,000? SP(U) SP(5,000) SP = $51 – VC(U) 25(5,000) FC 95,000 = = NI 35,0000 Example 6. Smith Co. has a contribution margin ratio of 40% and a breakeven point of $200,000 in sales. If the firm reports net income of $50,000 after taxes of 50%, what were total sales for the year? 0 = Sales – Variable Costs – Fixed Costs 0 = Contribution Margin – Fixed Costs 0 = $200,000(0. 4) – FC FC = $80,000 $50,000 = 0. 5[(. 4 x Sales) – $80,000] Sales = $450,000 Example 7 Sales Variable costs Contribution margin Fixed costs Net income Old $2,000,000 1,400,000 600,000 400,000 200,000 New $2,000,000 600,000 1,400,000 1,200,000 200,000 Note in this example that both Old and New have the same level of Sales and Net income. This means that the total costs for both Old and New are the same. However, the cost structure for each is different. This means that the breakeven point and profitability after breakeven are different for Old and New. In particular, Old and New have different Degrees of Operating Leverage (DOL). 10

Strategic Decision Making Candice Company has decided to introduce a new product, which can be manufactured by either of two methods. The manufacturing method will not affect the quality of the product. The estimated manufacturing costs of the two methods are as follows: Method A $5. 00 $6. 00 $3. 00 $2,440,000 Method B $5. 60 $7. 20 $4. 80 $1,320,000 Direct materials Direct labor Variable overhead Fixed manufacturing cost Candice’s marketing research recommends a selling price of $30 per unit. The fixed selling costs are $500,000 plus $2 per unit sold, regardless of manufacturing method.

A. Calculate the estimated break-even point in annual unit sales of the new product if Candice Company uses: 1) 2) Manufacturing Method A Manufacturing Method B B. Which production technology should the firm use? In particular, discuss the range for the level of output that would make Method A preferable and the range for the level of output that would make Method B preferable. 11 Extra Problem The following information pertains to ABC Company: 2004 $1,020,000 240,000 2005 $960,000 210,000 Sales Net Income Determine the breakeven sales for ABC Company. 12

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